A couple of articles caught my eye recently, both related to the topic of risk in investing and the best opportunities available to investors today.
The first, by Chuck Jaffe of MarketWatch, is titled “To be a winning investor, know the risks.” Jaffe cites a couple of recent studies that again confirm something we have known for a long time: investors are more likely to buy stocks or other securities when markets are rising than when they are falling, and they are more likely to sell when markets are in the dumps.
In doing so, investors believe they are avoiding risk, but they are in fact allowing their emotions to lead them to pursue a “buy high, sell low” mentality, which is detrimental to returns, to say the least. They are replacing market risk, the risk that the value of their assets might fall in the short term, with shortfall risk, the risk that they will not have enough money to meet their goals.
Tying this lesson into today’s opportunities brings me to the second article, written by James B. Stewart in the October issue of SmartMoney. Stewart discusses the angst that investors are feeling following the dismal returns provided by the stock market over the past decade, which has caused many to remain on the sidelines during the market’s recovery. He cites research, however, confirming that stocks have historically done well and have provided better returns than bonds and other asset classes following a decade of underperformance.
In attempting to avoid the risk that their investments decrease in value, investors are favoring the safety of bonds, particularly Treasurys, over the more promising long-term returns of stocks. Stewart argues that this is the opposite of what investors should be doing. He adds, “They should be putting more money into stocks, not pulling it out. This last, painful decade may turn out to have created an unusual opportunity to earn high returns in the stock market during the next 10 years.”
Both of these articles are consistent with our belief that investors should avoid being too cautious in the wake of the last few years’ market turmoil. Specifically discussing shortfall risk, Jaffe says:
Many investors take this risk when they are too conservative during troublesome market times or too aggressive when things are good. Investors who were whole-hog into tech stocks during the Internet bubble got hammered when it popped; today’s sideline sitter, conversely, might be missing out on low-priced stocks as they wait until they’re more comfortable.
We agree. Bonds and other income-generating securities are appropriate for many investors, often as part of a balanced portfolio. However, a dose of equities -particularly the well-capitalized, multinational, dividend-paying corporations that are available today at significant discounts to fair value – as part of a properly allocated portfolio can help to manage risk and maximize the chances for investing success.